PH’s Reform On The Construction Sector

Pushing the reset button on construction jobs

■ We downgrade the construction sector from Overweight to Underweight. Sector reforms under the new government post-GE14 puts all new projects under review.
■ We turn cautious on sector’s “Big Rail Theme”: ECRL, MRT 3, HSR, Gemas-JB 2T.
■ Potential knock-on effects include contract delays and downsides to job wins.
■ We raise RNAV disc. to cut TPs and to reflect a deterioration in sector’s sentiment.
■ We downgrade Gamuda and YTL Corp to Reduce (top Sells); Switch to Muhibbah Engineering which is our new post-GE14 top pick.

Pakatan Harapan (PH) is a big advocate of sector reform
The PH coalition led by Tun Dr Mahathir Mohamed, which has won GE14 by beating the previous incumbent Barisan Nasional (BN) coalition, is a big advocate of a reform of the construction sector. Although in principal, its manifesto is for the greater good over the longer-run, the blanket review on all contracts across-the-board (foreign funded included) will at the minimum pose delay risks, cap order book growth for contractors, and dent investors’ sentiment on the overall sector, in our view.

PH’s reform on the construction sector
Turning cautious on the sector’s “Big Rail Theme”
We turn cautious on contractors that are highly dependent on government contracts. The outlook for the “Big Rail Theme” has become uncertain, pending a comprehensive review by PH. We have also turned cautious on the progress of the RM55bn ECRL (awarded to, and funded by China), RM9.4bn Gemas-JB rail double tracking (awarded to Chinese consortium; pending an award to YTL-SIPP Rail), and HSR. We believe MRT 3 will be delayed, despite demonstrating huge spillover benefits to local industries and contractors.

Bearish undertones for the sector
We foresee three potential knock-on effects, supporting a likely bearish outlook on investor sentiment and share prices. The first knock-on effect is contract delays, the second is the actual impact on contracts via execution of PH’s manifesto, and the third is earnings impact on account of a downward revision of contract win assumptions and insufficient existing order book to cover for the possible delay, revision, or cancellation of outstanding new jobs. We expect more downside to KLCON Index, led by the big caps.

Raising RNAV discounts to TPs to reflect deterioration in sentiment
To account for a knee-jerk deterioration in sentiment, we raise RNAV discounts to lower target prices of all contractors under coverage (except for Muhibbah Engineering). Stock calls are now a combination of Reduce (mostly for big caps and election stocks) and Hold (for bombed-out stocks YTD with unexciting tender prospects). Muhibbah Engineering is now raised as our top sector pick as it is now a purer play on overseas contracts, lucrative airport concessions, and minimal exposure to rail jobs that will be under review.

Downgrade construction sector to UNDERWEIGHT
The GE14 results were a surprise to most contractors and the magnitude of PH’s victory over BN puts a high-chance of a reform of the sector’s tender, procurement and job award outlook, in our view, and one which we will monitor closely. We downgrade the sector from Overweight to Underweight. Gamuda and YTL Corp, previously our top post- GE14 big cap picks, are downgraded to Reduce, along with MRCB and Protasco, which were previously our preferred small-mid cap picks post-GE.

Short-term pain, longer-term gain
With the uncertainties on the contract roll-out coming into play, we expect the sector’s risk-reward to be unattractive over the medium term. The revival of the sector’s upcycle and the continuity of the RM225bn total outstanding jobs would depend on the new priorities to be outlined by the new government.

source:CGS-CIMB Research 13/5/2018